Three defensive companies that are long-term winners
Welcome to the final instalment of our ‘Super’ Sector Series of the Australian ASX300 excluding the ASX50 stocks. So far, we've heard about 'Innovators', 'Cyclicals', and 'Financials'. Now, Monique Rooney and I are exploring some of the current themes, risks and opportunities, portfolio considerations, and the long-term winners in 'Defensives'.
Monique Rooney: Hi, my name is Monique Rooney and I'm an analyst and an assistant portfolio manager on the Fidelity Australian Future Leaders Fund.
James Abela: Hi, I'm James Abela, the portfolio manager for the Australian Future Leaders Fund for Fidelity.
Monique: Welcome to the final part of our Super Sector Series, where today we'll be focusing on defensives. So, defensives include the food and beverage companies, real estate companies, telcos, and utilities.
James: So, the current themes is basically four sub sectors. So, in food and beverage is really about health and wellness. And that's a really, really big theme, as well as exporting, exporting sort of health and safety or health throughout Asia from Australia or New Zealand. The next one is telecoms and utilities where regulation is quite tight there. And then the net zero sort of movement towards ESG is really affecting telcos, but in particular utilities. Telcos more about 5G, and that's really the next evolution in the technology space in terms of telecoms. And the last one is in real estate, where REITS has been a really good place to be in the last little while as rates has been really low.
As rates are rising, they're under a bit of pressure, but real estate still is a very attractive area that still gives yield as yield is still scarce despite rates going up. It's still a scarce place and that's why it's still a good place to be.
Monique: For defensives, usually over the long run, returns are lower relative to the index just given they're low returning companies. But there are certainly times when exposure to these companies is very important. And usually that's when the market is volatile or overvalued. But where we also see opportunities is there are some higher returning businesses within defensives, and these have the opportunity to become future leaders.
James: So, the real risk that defensives face is really rising rates and rising regulation, especially in the power universe where you've got net zero and increased regulation towards ESG. That's a very significant regulation risk that space provides. The other one is interest rates. As interest rates start to rise, a defensives, which are low beta can tend to underperform. Also, if markets are strong and they're low beta, they can also tend to underperform. That's really where the risks sit for the defensive space.
Monique: When constructing a portfolio, they are lower return on equity, they are lower return on invested capital type businesses over the long run. But you can't ignore this sector. There's definitely periods of time when you need to have increased your exposure to this sector. And that's typically when markets are volatile, we're in periods of low beta and low growth environments. So, that includes 2009, 2016, 2019, and also this year in 2022. Usually it's when the value signals are strong and quite often for the quality momentum strong theme type stocks, valuations are extreme levels. So, we always need to be mindful of this but also outside of more volatile times and the times that I mentioned you need to be looking at the best of the defensives. What are generating higher returns and have the potential to be future leaders?
In defensives, some of the long term winners, I mean marketing competitive dynamics have changed more recently. But for the food exporters companies, like a2 Milk (ASX: A2M) and Blackmores (ASX: BKL) for a period of time, they made a lot of money from exporting to China. But then you've also got multi-laid REITS. So, your asset owners, your fund managers, and your developers, like Charter Hall (ASX: CHC), obviously rising interest rates is a bit of a headwind for that company at the moment. But for a long period of time, that's been a very strong performer. And then also, I guess on the other side of things is where you've got private money willing to pay a premium for these long duration, stable return businesses. You've seen a lot of takeouts in utility businesses recently. That's where the long-term winners are.
Listen to the rest of the Super Series
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3 stocks mentioned
1 fund mentioned
James has been portfolio manager of the Fidelity Future Leaders Fund since 2013, after joining Fidelity in 2003. Prior to that he worked at Constellation Capital Management, BNY Equities and Ernst & Young. James holds a Master of Commerce.
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